If you’ve made it past the Letter of Intent (LOI) stage of a commercial real estate deal, which we discussed in depth in a recent blog, you may feel like the hardest part is behind you.
The price has been determined, you have a closing timeline and everyone just wants to get to the finish line. But the next step, the Purchase and Sale Agreement (PSA), provides its own challenges. This is the legally binding contract that governs everything between the initial handshake and closing table. What it covers or doesn’t cover can have long-lasting consequences even beyond closing day.
Filling in the Gaps
The PSA fills in all the gaps the LOI may have, allocating the risk between the buyer and the seller in ways that can be very consequential, beyond just the price tag.
A PSA should address the following, and each of them deserves careful attention before you sign:
The due diligence period and what happens if something goes wrong
Title and survey review
Review of environmental issues
Review of zoning issues
Review of any existing leases for tenants occupying the property
Representations and warranties and what happens if they turn out to be false
Seller obligations between signing and closing
Escrow and deposit terms
Remedies for breach
The Due Diligence Period
Once a PSA is signed, the due diligence period begins. This window of time is when the purchaser is able to investigate the property, whether that’s physically, financially, legally, environmentally, etc. and determine whether or not they want to proceed to the closing. Obviously, sellers prefer a shorter due diligence period than buyers, as the window gives the buyer a right to walk away from the deal for any reason. And of course, buyers want time to conduct thorough investigations as well as lining up their financing.
What a thorough due diligence review includes:
Review of all existing leases and occupancy agreements
Environmental assessment (Phase I Environmental Assessment)
Physical inspection and engineering reports
Review of zoning compliance and any outstanding violations
Analysis of service contracts and management agreements
Financial review, including rent rolls, operating statements, and tax bills
Virginia buyers (and buyers in any state) should also be aware that zoning determinations can vary across jurisdictions, and local zoning counsel may be a good idea.
Title and Survey
A PSA’s title and survey provisions are how a buyer can confirm that the seller has a right to actually sell the property, and that there are no hidden encumbrances, easements, or boundary issues that could affect the property’s use or value. The purchaser’s attorney will review the title commitment and all underlying exception documents to identify any rights, restrictions, or obligations affecting the property. Additionally, surveys will be done to confirm the property’s boundaries, easements, encroachments, access, parking, etc.
For Virginia buyers, the forms of deeds and title insurance available can vary by jurisdiction, and transfer documents must be in recordable form under Virginia law. Local counsel should confirm that all instruments meet state and local recording requirements before closing is scheduled.
Representations and Warranties
Representations and warranties are statements by the seller about the condition of the property and the validity of the transaction itself. These provisions are heavily negotiated and their scope matters.
Common seller representations include:
That the property complies with applicable zoning and land use regulations
That there are no environmental violations or known contamination
That the seller holds valid enforceable title to the property and has authority to complete the sale
That all leases delivered to the purchaser are accurate and in full force
That the property is free of undisclosed liens and litigation
A seller will try to limit these representations to their “actual knowledge,” adding materiality qualifiers wherever possible. In distressed asset sales such as bank-owned properties, sellers will often give very few representations at all, which is generally accepted by the buyer as the tradeoff for the discounted price.
One of the most negotiated parts of representations and warranties is how long they survive closing and what the seller’s exposure looks like if one turns out to be false. Typically, a survival period of six to twelve months post-closing, along with a seller indemnification obligation for any resulting losses, is recommended.
Seller Covenants
The PSA’s covenant provisions are what protect the purchaser from the seller making material changes to the property’s income stream or condition between the PSA and closing.
Standard seller covenants typically require the seller to:
Operate and maintain the property consistently with past practices
Not enter into new leases or amend existing ones without purchaser approval
Maintain existing insurance levels
Notify the purchaser of any damage, governmental notices, or material changes
Deliver required tenant estoppel certificates in a form acceptable to the purchaser
Tenant estoppels deserve special attention. These are certifications from individual tenants confirming, among other things, that their leases are in effect, that there are no outstanding defaults, and that they have no undisclosed claims against the landlord. If the purchaser is financing the acquisition, the lender will almost certainly require estoppels as well.
Remedies for Breach
Both parties should enter a PSA with a clear understanding of what they can recover if the other side defaults.
Seller’s remedies are almost always limited to liquidated damages, meaning the seller can keep the buyer’s deposit in the event the buyer defaults on the agreement. While straightforward, sellers should negotiate clear escrow instructions on how that money will be retrieved from escrow after a default.
Purchaser’s remedies typically consist of termination and return of the deposit, but for larger transactions, purchasers should consider negotiating the reimbursement of out-of-pocket due diligence costs in the event of a seller default. Sellers who agree to this typically negotiate a cap on their reimbursement exposure.
Davis Law Group Can Help
At Davis Law Group, we work with buyers and sellers to negotiate and draft PSAs that consider all the aspects of a transaction. Getting this step right goes a long way in making closing day go smoothly. If you are preparing to enter into a commercial real estate purchase and have questions about the process, contact our office to schedule a consultation.
In our next blog in this series, we will walk you through the commercial closing process: required documents, prorations, settlement statement, and what to expect on closing day.
Commercial Real Estate Closings Part 2: Purchase and Sale Agreements
If you’ve made it past the Letter of Intent (LOI) stage of a commercial real estate deal, which we discussed in depth in a recent blog, you may feel like the hardest part is behind you.
The price has been determined, you have a closing timeline and everyone just wants to get to the finish line. But the next step, the Purchase and Sale Agreement (PSA), provides its own challenges. This is the legally binding contract that governs everything between the initial handshake and closing table. What it covers or doesn’t cover can have long-lasting consequences even beyond closing day.
Filling in the Gaps
The PSA fills in all the gaps the LOI may have, allocating the risk between the buyer and the seller in ways that can be very consequential, beyond just the price tag.
A PSA should address the following, and each of them deserves careful attention before you sign:
The Due Diligence Period
Once a PSA is signed, the due diligence period begins. This window of time is when the purchaser is able to investigate the property, whether that’s physically, financially, legally, environmentally, etc. and determine whether or not they want to proceed to the closing. Obviously, sellers prefer a shorter due diligence period than buyers, as the window gives the buyer a right to walk away from the deal for any reason. And of course, buyers want time to conduct thorough investigations as well as lining up their financing.
What a thorough due diligence review includes:
Virginia buyers (and buyers in any state) should also be aware that zoning determinations can vary across jurisdictions, and local zoning counsel may be a good idea.
Title and Survey
A PSA’s title and survey provisions are how a buyer can confirm that the seller has a right to actually sell the property, and that there are no hidden encumbrances, easements, or boundary issues that could affect the property’s use or value. The purchaser’s attorney will review the title commitment and all underlying exception documents to identify any rights, restrictions, or obligations affecting the property. Additionally, surveys will be done to confirm the property’s boundaries, easements, encroachments, access, parking, etc.
For Virginia buyers, the forms of deeds and title insurance available can vary by jurisdiction, and transfer documents must be in recordable form under Virginia law. Local counsel should confirm that all instruments meet state and local recording requirements before closing is scheduled.
Representations and Warranties
Representations and warranties are statements by the seller about the condition of the property and the validity of the transaction itself. These provisions are heavily negotiated and their scope matters.
Common seller representations include:
A seller will try to limit these representations to their “actual knowledge,” adding materiality qualifiers wherever possible. In distressed asset sales such as bank-owned properties, sellers will often give very few representations at all, which is generally accepted by the buyer as the tradeoff for the discounted price.
One of the most negotiated parts of representations and warranties is how long they survive closing and what the seller’s exposure looks like if one turns out to be false. Typically, a survival period of six to twelve months post-closing, along with a seller indemnification obligation for any resulting losses, is recommended.
Seller Covenants
The PSA’s covenant provisions are what protect the purchaser from the seller making material changes to the property’s income stream or condition between the PSA and closing.
Standard seller covenants typically require the seller to:
Tenant estoppels deserve special attention. These are certifications from individual tenants confirming, among other things, that their leases are in effect, that there are no outstanding defaults, and that they have no undisclosed claims against the landlord. If the purchaser is financing the acquisition, the lender will almost certainly require estoppels as well.
Remedies for Breach
Both parties should enter a PSA with a clear understanding of what they can recover if the other side defaults.
Seller’s remedies are almost always limited to liquidated damages, meaning the seller can keep the buyer’s deposit in the event the buyer defaults on the agreement. While straightforward, sellers should negotiate clear escrow instructions on how that money will be retrieved from escrow after a default.
Purchaser’s remedies typically consist of termination and return of the deposit, but for larger transactions, purchasers should consider negotiating the reimbursement of out-of-pocket due diligence costs in the event of a seller default. Sellers who agree to this typically negotiate a cap on their reimbursement exposure.
Davis Law Group Can Help
At Davis Law Group, we work with buyers and sellers to negotiate and draft PSAs that consider all the aspects of a transaction. Getting this step right goes a long way in making closing day go smoothly. If you are preparing to enter into a commercial real estate purchase and have questions about the process, contact our office to schedule a consultation.
In our next blog in this series, we will walk you through the commercial closing process: required documents, prorations, settlement statement, and what to expect on closing day.
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